Is Behavioral Economics Doomed? The Book!

David Levine’s essay is all grown up and now a full-blown book. His goal is to “set the record straight” and document the true successes and failures of economic theory. Here is a choice passage:

One of the most frustrating experiences for a working economist is to be confronted by a psychologist, political scientist – or even in some cases Nobel Prize winning economist – to be told in no uncertain terms “Your theory does not explain X – but X happens in the real world, so your theory is wrong.” The frustration revolves around the fact that the theory does predict X and you personally published a paper in a major journal showing exactly that. One cannot intelligently criticize – no matter what one’s credentials – what one does not understand. We have just seen that standard mainstream economic theory explains a lot of things quite well. Before examining criticisms of the theory more closely it would be wise to invest a little time in understanding what the theory does and does not say.

The point is that the theory of “rational play” does not say what you probably think it says. At first glance, it is common to call the behavior of suicide bombers crazy or irrational – as for example in the Sharkansky quotation at the beginning of the chapter. But according to economics it is probably not. From an economic perspective suicide need not be irrational: indeed a famous unpublished 2004 paper by Nobel Prize winning economist Gary Becker and U.S. Appeals Court Judge Richard Posner called “Suicide: An Economic Approach” studies exactly when it would be rational to commit suicide.

The evidence about the rationality of suicide is persuasive. For example, in the State of Oregon, suicide is legal. It cannot, however, be legally done in an impulsive fashion: it requires two oral requests separated by at least 15 days plus a written request signed in the presence of two witnesses, at least one of whom is not related to the applicant. While the exact number of people committing suicide under these terms is not known, it is substantial. Hence – from an economic perspective – this behavior is rational because it represents a clearly expressed preference.

What does this have to do with suicide bombers? If it is rational to commit suicide, then it is surely rational to achieve a worthwhile goal in the process. Eliminating ones enemies is – from the perspective of economics – a rational goal. Moreover, modern research into suicide bombers (see Kix [2010]) shows that they exhibit exactly the same characteristics of isolation and depression that leads in many cases to suicide without bombing. That is: leaning to committing suicide they rationally choose to take their enemies with them.

Probably Levine discusses this more in the book, but I think the quoted passage leaves out some important qualifications.

Of course rationality has no testable consequences without making some assumptions about the structure of preferences. And we do have a standard assumption about preferences: that, to a first approximation, people care just about the discounted sum of a concave function of consumption. (Prescott’s papers all push this hard, that the same simple set of preferences can explain all macro facts).

So if you’re writing a book defending rationality, are you defending discounted-consumption rationality, or some other preference structure? And if you come up with an alternative preference structure (does Levine?) does rationality still do important work? (because if you divide up actions finely enough, and add enough unobservables, eventually it becomes impossible to contradict the theory).

So if you believe in discounted-concave-consumption, then the prediction is that suicide should occur only for those whose permanent income is below some threshold. Is this what Levine finds? If he did, then I would say it’s evidence that “incentives matter”.

Often people say that incentives matter when they find that some decision responds to a change in costs/benefits (and costs/benefits are usually measured in consumption, i.e. this is the assumption on preference structure) (e.g. Summers Shleifer & Bernheim on bequests). This is important but hardly the end of the debate. Everything matters, if you have a big enough sample size (norms, habits, reflexes, the weather). We really want to know how much it matters.

I think most people think of suicide among young people as a problem in that they have a false belief that things will always remain this bad, but that belief is false. They are subject to a well-known distortion, & they need a reminder or a restraint, like a message that says “objects in the rear view mirror may appear closer..”, or like insisting that your child wear a cycle helmet, even though she doesn’t want to.

Of course the decision will also respond to incentives, but they’re still making a mistake. Just like the mistakes people make when they’re jealous or angry or turned on or procrastinating. Of course you could specify some preference structure to rationalise any of these, but (i) you should admit that you’re giving up on discounted-consumption preferences, and (ii) there’s a point at which the mechanics required to rationalise behaviour becomes more complicated than a simple explanation of people making systematic mistakes.

While Levine is a great economic theorist, he is not a good rhetorician. Hence a poor debater. If this quoted section is any indication, this book will prove to be poor defense by theorists against behavorialists.

I read the 20 page paper and agree that levine makes a strong case against prospect theory, but ironically,the fact remains that rational choice theorists have had to refine their models to respond to the behavioral critique — indeed, levine’s paper is devoted to persuading us of the effectiveness of the “rationalist response” to behavioral economics

Haven’t had time to read the essay, but Levine’s piece on Thinking, Fast and Slow leaves an enormous amount to be desired.

Levine attempts to take on the endowment effect by reporting on a study done by people who have folks exchange a piece of paper for money. As it happens, I’m old enough to remember these things called, “checks” (and, by “old enough,” I mean, “old enough to be able to understand the concept of a ‘check’ and have actually seen one after I learned the concept” — so, roughly, older than about 2). This ignores the fact that, as it happens, people use this stuff called, “cash,” as a representation of money – where the denomination/value of the piece of paper is fairly explicit (in that it’s written on the piece of paper).

So – the idea that people might glom onto a piece of paper being worth a specific amount – no more, no less – is, well, something that probably every single participant in the study had been trained to do for more than a decade (assuming the participants are all over 18). The fact that people then did what they’ve been explicitly trained to do should surprise, or be of any interest whatsoever, to exactly no one (except, evidently, the economists who bothered to waste the time/money to do it, and also Levine).

Now, do we have reason to think that people might act differently if, instead of paper, they were given something useful (such as a cup)? Well, sure: once I have something, I think of how to use it; its utility goes up, because it’s in my hand, and it’s mine. The one that I’d still have to buy (where the money could be used for other things)? Naturally – and, frankly, completely rationally – that would have a lower utility for most sentient beings.

Now, wouldn’t it be great if someone actually ran an experiment to see if people operate differently when receiving pieces of paper worth $X versus when they receive a gift of some kind that’s worth $X? Someone should really run that experiment, you know?

Oh, wait – right: someone did run that experiment. In 2004, a mere 8 years before Levine wrote his HuffPo bit.